20-06-2014, 02:21 PM
red chip
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LIMITED RECOURSE BORROWING ARRANGEMENTS
Stephen Harvey – Seminar Paper 2013
We have seen a significant increase in super fund borrowing since the rules changed in 2007 and again in 2010. After a slow start, most advisors are now aware of the possibilities and the opportunities for gearing into large illiquid assets using the equity in super funds.
Recent press and internet chatter about using SMSFs to buy into previously unattainable asset classes is driving many self managed funds to enquire about exposure to the benefits of gearing.
Most of the activity we see is aimed squarely at real estate in a market where values seem to be holding up and, given the long term nature of the investment, fit nicely into the investment strategies of some SMSFs.
While there are obvious attractions in this space, the rules dictated by the Superannuation Industry (Supervision) Act 1993 ("SIS”) and the ATO, are complex and technical and can present traps to those who are unfamiliar with the strict requirements of those rules. Being familiar with the rules does present some challenges but the opportunities seem to be there for some SMSFs to exploit.
RISKS
Getting the structure wrong can have some significant risks including:
A non-complying loan or structure can result in the whole fund becoming non-complying. The fund’s concessional tax treatment may be lost if that occurs – meaning tax at 46.5%;
If the loan is non-complying, the only solution may be to repay the loan immediately or to unwind the structure and sell the asset, triggering significant costs and potential capital losses.
By way of example, we recently advised regarding a structure set up for a LRBA which used a unit trust as the vehicle to acquire real estate. The unit trust borrowed the money and gave security over the asset. The relevant SMSF was a majority unit holder with the 2 members of the fund being the other unit holders. This presented the client with the following dilemma:
(a) the borrowing was undertaken by the unit trust rather than the SMSF. If the SMSF does not borrow or does not maintain a loan, the general prohibition in Section 67 against borrowing applies and the exemption in Section 67A did not apply in this case;
(b) since the SMSF’s unit holding was an investment in a related trust and since the unit trust had borrowings and the property was subject to a charge, the SMSF’s unit holding was an in-house asset and was required to represent less than 5% of the fund’s assets;
TA 2012/7 makes it clear that the ATO consider this structure as non-complying.
The net result was that the SMSF was faced with 2 immediate solutions neither of which was desirable – either the unit trust must repay the borrowings or the SMSF must divest itself of the unit holding.
Multiple titles
In the case of real estate, often the SMSF trustee will have multiple titles to contend with. This requires separate bare trusts and separate loans for their acquisition. For example:
Apartments – apartments, particularly in newer developments, commonly include a right to occupy or to use a car space or storage unit. Where the additional right is only a right given by the relevant Community Titles Scheme, there should be no issue. However, where the car space or storage unit are held on a separate title and the buyer acquires not 1 but more than 1 title, there may be more than 1 acquirable asset. The ATO recognizes (SMSFR 2012/1 para 58) that where a strata plan contains a restriction such that if the car park/storage unit and apartment are not transferred together the transfer of title of the apartment cannot be registered, then this is a single acquirable asset.
Commercial premises over multiple titles – if a SMSF wishes to acquire premises which comprise more than 1 title, there must be a significant structure which unifies the titles. Where a structure straddles more than 1 title, the multiple titles will only be considered a single acquirable asset where the structure comprises a significant part of the value of the entirety (SMSFR 2012/1 para 49 - 51). On the other hand, if the structure covers 2 titles and a third title is to be included as part of an acquisition this would constitute 2 titles.
THE CUSTODIAN TRUST
Neither SIS nor the ATO mandate the type of trust that should be used to hold the acquirable asset. All that is required is that the asset be held on trust, the SMSF acquires a beneficial interest in the asset and that the asset is the only asset of the trust.
The prevailing view and certainly that of ACIS/Redchip, is that a simple or “bare trust” be used for the purposes of the borrowing rules. A bare trust is one in which the beneficiary acquires a beneficial and generally indefeasible interest and where the trustee has few (if any) positive obligations other than to hold the trust assets. Using a form of trust other than a bare trust may also lead to adverse taxation or stamp duty outcomes. Mark will touch on these issues later.
In addition, the ATO’s view is that more complex trusts are unlikely to satisfy the requirement that the SMSF trustee has the necessary interest in a particular asset of the custodian trust. For example, a discretionary trust could not be used, nor could the SMSF trustee be one of a number of unit holders in a unit trust. (see the ATO’s Q & A on limited recourse borrowing arrangements http://www.ato.gov.au/superfunds/content...age=47&H47). This last point is interesting since a unit holding is itself an acquirable asset.
The ACIS/Redchip trust deed are asset specific trusts in keeping with the primary requirement of s67A ie that borrowed money be used to acquire a single acquirable asset.
The “bare trust” can hold no other assets – the only asset of the trust must be the single acquirable asset although if the “bare trust” holds cash in a bank account this appears to be permitted but only if the cash is used for maintaining the asset. Using the cash for trading purposes is not permitted.
Because of the nature of the custodian trust and SIS, once an asset is disposed of by the SMSF/custodian trustee whether by transfer back to the SMSF or to a third party, the bare trust ends and cannot be re-used. To do so would contravene the restrictions on acquiring replacement assets unless the original asset was shares or units (see the ATO’s Q & A on limited recourse borrowing arrangements).
WHO IS THE TRUSTEE OF THE BARE TRUST
The asset being purchased must be held in a trust that is completely separate from the SMSF. This is one critical element of the ability of a super fund to borrow. It is strongly recommended, in all cases, that the custodian trustee should be a corporate trustee established for the purpose of holding the asset being acquired and should not undertake any other activities. Importantly:
the Trustee of the custodian trust must not be the same as the Trustee of the SMSF - the ATO has expressly indicated that to do so is inappropriate as this would breach the requirement that the asset acquired be held in a separate trust. The interest of the trustee and the interest of the beneficiary merge. The custodian trust would cease to exist and the borrowing and the fund would become non complying;
similarly, if the custodian trustee is an individual and is potentially a beneficiary (member) under the SMSF then there may be a merger of the interest of the trustee and the beneficiary. The custodian trust may cease to exist and the borrowing and the fund would become non complying;
if the custodian trustee is an individual and, for example, dies or becomes bankrupt, the interest held in the bare trust would likely devolve to the beneficiary or the legal personal representative of the trustee or the trustee in bankruptcy. The custodian trust may cease to exist or the custodian trust falls under the control of other persons and/or the borrowing and the fund would become non-complying.